NY futures rallied strongly this week, as December gained 399 points to close at 71.71 cents.

Just a little over a week ago a negative reaction to the WASDE report saw the market sell off to a low of 66.44 cents on September 13 and the accompanying drop in volatility suggested that we would see a rather boring trading range going forward. However, a flare up in Chinese and Indian prices eventually spilled over into the US futures market, with new spec buying igniting a rally that lifted prices by over 500 points since the middle of last week.

Prices in China’s futures market rallied more than 800 Yuan/ton or around 540 points/lb since last week to over 102 cents/lb in the most actively traded contract, while cash prices are at around 97-98 cents/lb. With auction sales to be suspended at the end of the month, mills are trying to hoard as much cotton as possible in order to avoid price volatility at the beginning of new crop. So far total auction sales have reached 2.44 million tons or about 11.2 million statistical bales.

In India prices for nearby delivery have jumped higher as well, with Shankar-6 fetching around 92 cents ex-gin. However, prices for Dec/Jan delivery are being heavily discounted since it is not believed that the current price plateau can be maintained once new crop arrivals increase. While recent rains may have delayed arrivals, they were overall beneficial for plant development and local sources are quite optimistic that the crop might reach 34.5-35.0 million local bales, or about a million bales more than last season.

In the seven sessions since September 13 total open interest has increased by 13,162 contracts or 1.32 million, whereof 8,065 contracts were in the December contract. The expansion of open interest leads us to believe that it was new spec buying into trade selling that forced prices higher. If it had been trade short covering, then open interest would have been reduced.

The latest available CFTC report as of September 13 showed speculators at 7.8 million bales net long, but after this latest round of spec buying we expect them to be close to 9.0 million bales net long by now. The trade was 15.15 million bales net short as of last week, which is substantially more than at the same time a year ago, when it carried only a 9.4 million bales net short position.

These relatively large net positions by the market’s main players lead us to believe that the specs don’t have much more room to expand their net long, since their highest position ever was around 11 million bales, while the big trade net short argues for solid underlying support, as many of these trade shorts will get bought back on price breaks due to mill fixations and sales of basis-long positions. In order to keep the current rally going either additional spec buying or trade short covering is needed, both of which is not likely to happen in substantial quantities.

By focusing on the tug-of-war between speculators and the trade, we may have overlooked how much money has poured into index funds recently. Since the beginning of July the net index fund long position has increased by 1.2 million bales, from 6.1 to 7.3 million bales. According to Barclays commodity investments saw record inflows of USD 54 billion in the first eight months of this year, as investors are looking for diversification and inflation protection.

The more longs index funds occupy, the more they alter the ratio between market-driven spec longs and trade shorts. Last week we had basically one spec long for every two trade shorts. While this may not matter much in an oversupply situation, it can exacerbate market moves in a scenario in which shorts feel the need to cover. So far the trade has held its ground and as long as the crops materialize as expected, there seems to be no reason to panic.

US export sales for the week that ended on September 15 amounted to 215,800 running bales of Upland and Pima cotton, which was slightly below expectations. There were 18 markets participating in the buying, while 21 destinations received shipments of 165,500 running bales. For the season we now have commitments of 5.4 million statistical bales, of which 1.3 million bales have so far been exported. Current commitments run 2.2 million bales ahead of last year!

So where do we go from here? The market has quickly moved to the higher end of our perceived 66-71 cents trading range and it remains to be seen whether it can keep the momentum going. What speaks against it is that specs are already quite long, while the trade doesn’t seem to panic into covering shorts. The crops in China, India, Pakistan and the US are doing fairly well at this point and as long as that remains the case, we don’t see any reason for the trade to chase prices higher.

However, given the strength this week we need to adjust the trading range slightly higher, with the 66/67 level seeing solid support and the 72/73 area providing resistance.

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